Standing Committee A

[Sir John Butterfill in the Chair]
(Except clauses 13 to 15, 26, 61, 91 and 106, schedule 14, and new clauses relating to the effect of the provisions of the Bill on section 18 of the Inheritance Tax Act 1984)

Schedule 12

Settlements: amendment of TCGA 1992 etc

Question proposed [this day], That this schedule be the Twelfth schedule to the Bill.

Question again proposed.

Dawn Primarolo: Good afternoon, Sir John. I welcome you to the Chair. I am grateful that my back is to the window and, although I cannot see the beautiful blue sky, I am sure we shall make good progress this afternoon.
Before lunch I was responding to certain questions that had been asked by the hon. Member for Chipping Barnet (Mrs. Villiers) on the operation of schedule 12, one of which was about the definition of “making” in relation to settlors and settlements. Many of her questions are technical, but I shall respond as well as I can and make some general comments at the end.
The legislation refers to a settlor making or entering into a settlement. A settlor will make a new settlement or enter into an existing settlement. When trustees declare new trusts over settled property by way of a deed of appointment, the property may be held on a new settlement trust, provided that that is within the powers of the trustees. The question, however, is one of fact and law, and the particular issue that the hon. Lady mentioned has been the subject of several court decisions. The position under the proposed legislation is therefore the same as previously.
The hon. Lady also asked about new settlors adding property to an existing trust. Whether there is an addition to an existing trust or a new settlement is a matter of general law. As was the case before the drafting of the schedule, the tax rules apply by reference to the legal status; they do not themselves determine the question. So I wish to reassure her that the purpose of the provisions is to achieve exactly the changes that were identified by the Government.
On the definition of settlor interest, the purpose of the trust modernisation package is, as I have already said, to harmonise as much as possible the treatment of trusts for income tax and capital gains tax purposes. That will help with compliance by trustees—especially in the case of smaller trusts—because it will help them not to be tripped up inadvertently by differences between rules.
The capital gains tax rules on settlor-interested trusts are more generous than the income tax rules, and lend themselves to avoidance opportunities that we do not want to extend to the income tax regime. It is true that some people have created trusts for their children in order to take account of the annual exempt amount. The main purpose of the new rules, however, is not to stop that abuse but to align income tax and capital gains tax treatment more closely, as I said originally. Tackling one small area of avoidance in isolation would increase complexity rather than simplify matters, whereas the driving imperative for the provisions is one of simplification.
All trusts set up by living parents for their minor children will now be treated as settlor interested. We think that it is right that the tax system should reflect the effective financial dependence of minor children on their parents, so parents will no longer receive capital gains tax advantage if they choose to set up a trust for their children. The principle of charging tax on gains of settlor-interested trusts at the marginal tax rate of the settlor remains a fair policy.
Mrs. Theresa Villiers (Chipping Barnet) (Con) rose—

Dawn Primarolo: I shall give way, but I shall just conclude this point, because the hon. Member for Ludlow (Mr. Dunne) asked about it.
Trusts set up for children on the death of a parent will benefit from the favourable tax regime for vulnerable beneficiaries provided that the conditions are met. The hon. Gentleman specifically asked that question with regard to disabled children. The short answer to his question about whether they would receive the beneficial arrangements is yes. The benefit of the regime would apply in those circumstances—uniquely, because of the carve-out that the Government have already made.

Theresa Villiers: The Paymaster General outlined an underlying rationale for equating capital gains tax in respect of trusts for under-18s with that of the parents. Are the professional associations correct in asserting that the new rules will not apply to bare trusts for under-18s? If so, why are the Government introducing different rules for non-bare trusts in that instance, which is so controversial, while retaining the old approach for bare trusts?

Dawn Primarolo: I was looking quickly through my papers, because the hon. Lady referred to bare trusts. The answer to her question is yes. The measure does not affect gifts to dependent, minor children other than gifts to a trust, because there is a difference between an outright trust and a gift into a trust where the settlor generally retains a degree of control over the assets. She need not worry about the problem that she identified. It will not be an issue.
The hon. Lady then moved on to a discussion about holdover relief. Parents have used the tax rules favouring trusts for minor children in various ways—by protecting family assets and enhancing family income. The new rules reflect the principle with which we are familiar from income tax, in which a minor child’s income that originates from a parent should be regarded as the income of that parent. Assets held in trust for minor children, with the exception that the hon. Gentleman raised and I have confirmed, should be regarded in the same way for capital gains purposes. 
The hon. Lady asked whether there might be a double charge, and she identified a possible interaction with inheritance tax. Such a scenario is highly unlikely, because there will be no inheritance tax charge if the asset qualifies for agricultural or business asset relief, or if the transfer falls within the nil-rate band. There will be no capital gains tax charge except to the extent that the assets put into the trust are chargeable assets standing at a gain. In the unlikely case that a charge to inheritance tax arises on the transfer, it will be deductable in calculating the gain on the disposal by the trustee to whom the transfer was made.
The hon. Lady referred to the Budget note. I can confirm that she is correct in her assertion that it was wrong—[Hon. Members: “Ah!”] Her Majesty’s Revenue and Customs has already apologised for that and made the correction. I understood that she would raise that query if she were working from the Budget note. She might have been about to ask me about that next.

Theresa Villiers: I was, yes.

Dawn Primarolo: Okay, fair cop. The Budget note was wrong, but it has now been corrected and apologies have been made.
The hon. Lady asked about sub-funds. As I said in my introduction, their creation was at the request, in specific circumstances, of some people whom we consulted. We were happy to provide for that. The option to make a sub-fund election, which she mentioned specifically, will assist trustees whose trust deeds do not allow them the freedom to treat sub-funds as a separate trust. It puts them in the same position for tax purposes, including the availability of tax relief where the relevant conditions are met, as, for example, trustees whose deeds already allow that degree of flexibility.
The hon. Lady went on to talk about holdover relief. Providing a general holdover relief would give more favourable tax treatment to trustees who opted to make a sub-fund election compared with the trustees of trusts who set up a new trust under the existing power. That would clearly be unfair and would be an accident of timing as well as of drafting. It would be illogical and could open the door to pretty substantial capital gains tax avoidance opportunities. I am not attracted to that. As I said, the measure for the election of the sub-fund is designed to solve a specific problem that was raised in the consultation period. It is therefore entirely appropriate that it is structured in the way that it is.
The hon. Lady identified in her opening remarks that this is a complex issue. I have tried to explain in my contributions this morning and this afternoon that this is about attempting to align as closely as possible the treatments for capital gains tax and income tax. Much of this is underpinned by the written rule of law and the courts as opposed to tax determining the situation in the first place.
Despite the fact that this matter was consulted on from December 2003, with draft clauses made available, HMRC will publish new guidance. If Members of the House or those outside it who read our proceedings have particular points that they consider need clarifying further, HMRC officials will be available to discuss them and ensure that the guidance issued would put them beyond any doubt. I hope that the hon. Lady finds that helpful and that most of her fears have been assuaged.

Theresa Villiers: I welcome the last part of the Paymaster General’s address to the Committee. There is clearly a case for additional guidance about these laws. On many occasions during our consideration of this Finance Bill, I have been able to take great reassurance from clarifications and undertakings given by Ministers. However, in this case, I remain worried about what is in the Bill. It might be something that the Opposition should consider coming back to later in the discussions on the Bill.
The Paymaster General refers to the advantages provided by these schedules in terms of simplification for the trustees of smaller trusts, because they would have to deal with fewer definitions. It is difficult to classify the phenomenally complex provisions, and I have struggled with them at length over the past couple of weeks. I therefore have a degree of doubt that they contribute to simplification.
I am genuinely anxious about the imposition of penal treatment of transfers into trusts and the extension of the definition of settlor interest in trusts. I heard what the Minister said about why it is being done, and it seemed that the key reason was simply to align the treatment for income tax with that for capital gains tax. Given the significant penalty involved, we need a stronger benefit to justify the change. I do not accept that trustees will gain so much advantage from a simpler system that they will not mind paying a whacking great CGT charge. The Paymaster General and I are simply not as one on the matter.
I continue to be worried about the arbitrary distinction which means that bare trusts for under-18s will be treated differently from substantive trusts for under-18s and trusts for over-18s, which will not receive the same penal treatment. One type of trust—an ordinary trust for under-18s—will be penalised. Even after the Paymaster General’s helpful and extensive discussion of the schedule, I cannot understand why that distinction is being drawn. She tried to assure us that very seldom would cases occur in which there is an IHT hit and a CGT hit, but she drew our attention only to the exemption from CGT for agricultural business assets and the fact that there will be an allowance for CGT. That still leaves a range of ways in which trusts could be hit. There will be a significant extra tax charge, and if the motivation is simplification and the wish merely to harmonise two sets of legislation, there will be sufficient negative consequences for the measure not to be justified on a cost benefit analysis.
As I acknowledged in my speech on clause stand part, I accept that the request to set up sub-funds came from the professionals themselves. However, there is a case for distinguishing the setting up of sub-funds from the setting up of a wholly new settlement. They are part of the existing settlement, so it seems only reasonable to allow a holdover into the sub-fund. In essence, such funds are not being transferred. I end by repeating my point that if the Government want to respond to the request for sub-funds made in the consultation, they must create a system that people will use. People will not use the proposed system, because any administrative savings that they might make as a result of being able to run sub-funds rather than running everything as part of one trust will be outweighed by the new tax charges. I am grateful to the Paymaster General for her clarifications, but I remain concerned about the schedule.

Question put and agreed to.

Schedule 12 agreed to.

Clause 89 ordered to stand part of the Bill.

Schedule 13

Settlements: amendments to ICTA andITTOIA 2005 etc

Theresa Villiers: I beg to move amendment No. 186, in schedule 13, page 66, line 19 [Vol II], leave out paragraph 2.

John Butterfill: With this it will be convenient to discuss Government amendments Nos. 191 and 192.

Theresa Villiers: I assure the Committee that this contribution will be much shorter than my previous one. I should make it clear that the Opposition have no objection in principle to Government amendments Nos. 191 and 192, which seem to make useful improvements to the Bill, although we believe that there are other problems in the schedule that they do not cover.
Amendment No. 186 is a probing amendment designed to deal with an anxiety that has been raised about paragraph 2, which it would delete. Previously, trustees of settlor interested trusts were not charged income tax under section 686 of the Income and Corporation Taxes Act 1988 because the income was deemed to be that of the settlor, who was charged instead under section 619 of the Income Tax (Trading and Other Income) Act 2005. Paragraph 2 deletes section 686(2)(b)(ii) of the 1988 Act and the effect is to remove trustees’ immunity from tax in that situation, which they currently enjoy because the tax is paid by the settlor. There does not seem to be a corresponding credit anywhere else, so at the moment, paragraph 2 of the schedule will make trustees liable for a tax that the settlor is also being asked to pay. I am sure that it is not the Government’s intention to levy tax on the same income twice, so I have tabled my amendment to give them the opportunity to reassure the Committee that there will not be a double charge in this case.

Dawn Primarolo: I shall give the hon. Member for Chipping Barnet the assurance that she is looking for. I could explain why the amendment is defective as well, but she has said that the amendment is a probing one designed to get my assurance that there are not two tax charges. That is not the case. The total is 40 per cent. and under the old regime, it was the proportion paid by the trust, topped up by the settlor if necessary—if they were a higher rate payer. The 40 per cent. figure is not covered by specific tax legislation but by general law. The provisions are only arranging for it to be paid in one place, rather than having an administrative process where the top-up is paid subsequently to the 40 per cent. figure. The provisions do not prevent the 40 per cent. tax being made available as a credit to the settlor, if they are not liable for the 40 per cent. Some people outside the House have misread the provisions, which has led them to believe that there might be the 40 per cent. and the 37, which is not the case. It would be underscored slightly more if that were the case.
I am not going to speak to the Government amendments, except to say that I am glad that the hon. Lady welcomes them. It was noted that the way in which the regime was drafted was slightly harsher—to put it mildly—than intended and the Government amendments restore the position to that set out previously, which should have remained all along. That has been widely welcomed. With that assurance, I hope that the hon. Lady will withdraw her amendment.

Theresa Villiers: I am grateful for the Paymaster General’s clear assurance that there will be a credit, and that, where the settlor has paid the tax, the trustees will not have to pay. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: No. 191, in schedule 13, page 68 [Vol II], leave out lines 6 to 8.
No. 192, in schedule 13, page 72, line 9 [Vol II], at end insert—
‘(1A) For section 623 of ITTOIA 2005 (calculation of income) substitute—
“623 Calculation of income
For the purpose of calculating liability to tax under this Chapter (but for no other purpose), a settlor shall be allowed the same deductions and reliefs as if any amount treated under this Chapter as income of the settlorhad actually been received by the settlor.”'.—[Dawn Primarolo.]

Question proposed, That this schedule, as amended, be the Thirteenth schedule to the Bill.

Theresa Villiers: Again, I can assure the Committeethat the debate will be much shorter than that on schedule 12. I am conscious that people do not find this the most exciting thing in the Bill. [Interruption.] I am trying.
As we heard, schedule 13 introduces changes to income tax similar to the ones we discussed on capital gains tax. I want the Paymaster General to consider some of the points raised by the professionals. The first of those concerns new section 685 of the Income and Corporation Taxes Act 1988 and the meaning of separate property. I am told that the new section will mean that some trusts become bare trusts for income tax purposes, so that the beneficiaries rather than the trustees will be liable to pay the tax. The Institute of Chartered Accountants has pointed out how significant an administrative change that will be for the trusts involved. It asks whether there is a possibility of postponement of implementation to give trustees the opportunity to prepare for the measure.
A point that runs through the changes that we are discussing in schedules 12 and 13 is that they will involve more work for the Inland Revenue on specialist trust taxation. Two of the specialist centres dealing with trusts and tax were recently shut down by the Inland Revenue. It would be useful to have the Paymaster General’s assurance that the additional implementation costs and administrative burden on the public sector, because more trusts will be making tax returns than was previously the case, have been taken into consideration in the decisions taken by the Government on the Bill.
On new section 685(B) of the Income and Corporation Taxes Act, the same issues arise on the meaning of “settlor” as do on schedule 12. I need not delay the Committee with them but put on record that the same anxieties apply here as we just discussed on capital gains tax. The same point can be made about new section 685 on transfers between settlements.
The last point about the schedule concerns paragraph 4, which introduces new section 686(E) of the Taxes Act. It deals with multiple settlements and is an anti-avoidance provision. The concern is that the measure is a complicated response to a problem that will not arise. It is not a disaster if it goes on the statute book, but it is a complicated reaction that is not necessary. It provides for new rules to be applied where a settlor sets up multiple settlements. In this situation, it provides that the basic rate tax band of £1,000 will be split between the settlements with a minimum of £200. The avoidance that it is concerned with is the idea that a settlor might set up many trusts to try to take advantage of the £1,000 band.
However, it has been pointed out by the professionals—for example, by the Chartered Institute of Taxation—that the costs and hassle associated with setting up trusts are so significant that there is not much risk that the abuse that the Government fear will happen. I have sympathy with those concerned, given the significant costs of running separate settlements. While I do not have a huge problem with new section 686(E), I query whether it is necessary considering the significance of the problem with which it is designed to deal.
There are significant problems on schedule 13, but they are largely the same as those that we discussed extensively on schedule 12. Therefore, I need not detain the Committee further on them.

Dawn Primarolo: The hon. Lady has considered the issue closely. She says that there are substantial problems with the two schedules. All I can say to her is that, given the points that were made during the consultation on draft clauses from December 2003, her fears are not borne out by an overwhelming reaction. The Government would have expected such a reaction to the proposals about the clauses.
I have been sitting here thinking that the next time my civil servants say to me, “Trustees think it would be a good idea to simplify things a little so that instead of operating two sets of rules on capital gains and income tax, we align them as closely as possible—wouldn’t that be a nice thing to do, Minister?”, I shall say no.
This whole discussion, preceded by the consultation, demonstrated how clearly the alignment and changes were welcomed by those in the specific field. That just goes to show that, no matter what a Government do with the tax system, nobody ever believes a Treasury Minister when they say, “Trust me, I’m from the Treasury and I am here to help you.”
Bare trusts have never had to self-assess. They are blind trusts and are described in various ways. They are, and always have been, taxed in a slightly different way. That was clearly spelled out in tax bulletin 32. The hon. Lady has studied a great deal, but even she may not have trawled through every single tax bulletin—[Interruption.]. Okay, she has; congratulations. Bare trusts remain able to self-assess with respect to their income, although not their capital gains tax.
The hon. Lady asked also about whether the impact on the public sector had been taken into account. The answer is yes; if anything, administration costs will be marginally reduced—only marginally, as a complicated area is being brought together. Finally, the hon. Lady asked about the standard rate band. It is at a relatively modest level, having been increased to £1,000 this year. 
There will now be a minimum £200 standard rate band applying to all trusts created by the same settlor, regardless of how many trusts that settlor has made; that strikes the correct balance between assisting on this issue and trying to deter anyone who wanted to abuse the standard rate, although I am sure that no one will. There is a combination of measures. Raising the level to £1,000 takes another 5,000 trusts out of the self-assessment system, on top of the 25,000 that were taken out by the £500 change last year.
I have listened carefully to the hon. Lady; perhaps I shall listen more closely next year. I sincerely hope that her fears are unfounded and shall do my best to ensure that the clauses and schedules operate exactly as the consultation indicated. Taxpayers expect the issue to be taken forward.
The hon. Lady said that she did not know whether the change should be called a simplification, but that depends on where one starts. The provisions are better than previous ones. It is most definitely a simplification, but this will never be an easy area of tax.

Question put and agreed to.

Schedule 13, as amended, agreed to.

Clause 90

Special trusts tax rates not to apply to social landlords’ service charge income

Question proposed, That the clause stand part ofthe Bill.

George Young: The clause seems wholly commendable. It reduces the tax payable on trusts for which tenants and leaseholders have paid their service charges from a higher to a lower rate, and I am sure that it will be welcomed by social landlords and local authorities.
I have two questions for the Minister. We are amending the Income and Corporation TaxesAct 1988, so I assume that for the past 17 or 18 years registered social landlords and local authorities have been paying the high rate of tax—either 40 per cent. or 32.5 per cent. As directors of finance in both kinds of organisation are shrewd individuals, why has it taken them so long to put up their hands and protest at the relatively high rate of tax that they have to pay? Perhaps the Paymaster General can explain how the problem came to light. My other question is related to that, but the Paymaster General may not have the figures at her fingertips. How much extra money have local authorities and registered social landlords paid over the odds by being subject to the high rate of tax instead of the lower one that the clause introduces, and as a gesture of benevolence would the Treasury consider giving back to local authorities and registered social landlords the excess sums that they have paid?

Julia Goldsworthy: I have just one further question to ask the Minister on the issue. I have received representations about concerns that some regimes may fall outside the changes to the special trusts’ tax treatment. In particular, residents’ associations that set up sinking funds rather than having service charges may set up discretionary trusts without realising it, and so may not fall under this new tax treatment. I would appreciate the Minister’s reassurance that efforts will be made to inform the associations that there is a more beneficial means of undertaking such treatment of service charges, or a reassurance that the new treatment will be extended to such sinking funds.

Rob Marris: I welcome you to the Chair, Sir John. My point is on similar lines to those of the previous two speakers. I understand that the provision does not apply to private landlords, but can my right hon. Friend the Paymaster General say whether it applies to housing co-operatives and/or tenant-managed co-operatives?

Dawn Primarolo: I do not want to go down the route of giving money back—not today, anyway. I can tell the right hon. Member for North-West Hampshire(Sir George Young) that the issue came to light as a consequence of the rate change for trusts in 2004, so it has not been going on for long. The Office of the Deputy Prime Minister and the Housing Corporation had it drawn to their attention, so they came forward to the Treasury on the basis that the problem was the interaction with service charges, sinking funds and the use of regulations. Of course, the smaller cases are covered by the exemptions, which were £500 and then £1,000. We are not talking about a substantial amount of money, and the changes are negligible in terms of calculations for the Treasury. As the right hon. Gentleman will know, being an ex-Treasury Minister, that means that the amount is less than £500 million and is not calculated. [Interruption.] £5 million; did I say £500 million? Well, then I should apologise to the Committee, because that would be a large error. I am sure that the Chancellor would be very cross with me.
With regard to who else the clause will cover, whether it will cover tenant-managed co-operatives, and the points raised by the hon. Member for Falmouth and Camborne (Julia Goldsworthy) and my hon. Friend the Member for Wolverhampton, South-West (Rob Marris), I will need to check those points. I hope that the clause will cover tenant-managed co-operatives, because the whole point was to cover that sector. The clause does not cover private landlords. I intend to monitor the measure, which is clearly sensible, when it comes in and will see what benefit it has with regard to the social housing sector. Then, if it is clear that we need to make further changes, we will bring them forward at the correct time.
With my clarification of my inadvertent slip, and having assured the right hon. Gentleman that this is a good measure and that the issue only recently came to light, I hope that the Committee will accept the clause, which I commend to it.

Question put and agreed to.

Clause 90 ordered to stand part of the Bill.

Clause 92

Avoidance using options etc

Mark Hoban: I beg to move amendment No. 135, in clause 92, page 84, line 34[Vol I], leave out subsection (2).

John Butterfill: With this it will be convenientto discuss the following amendments: No. 136, inclause 92, page 84, line 35 [Vol I], leave out
‘insert at the beginning “securities”'
and insert
‘after “options”, insert “other than an option which is acquired pursuant to a right or opportunity made available under arrangements the main purpose (or one of the main purposes) of which is the avoidance of income tax or national insurance contributions”.'.
No. 137, in clause 92, page 84, line 39 [Vol I], after third ‘of', insert ‘income'.
No. 138, in clause 92, page 85, line 1 [Vol I], at beginning insert
‘Subject to subsection (6) below,'.
No. 140, in clause 92, page 85, line 1 [Vol I], leave out from ‘after' to end of line 4 and insert ‘22nd March 2006.'.
No. 139, in clause 92, page 85, line 4 [Vol I], at end add—
‘(1) Where any liability to income tax or national insurance contributions arises by virtue of this section, such liability shall not fall to be collected through the PAYE system unless the option in question was acquired on or after the date Royal Assent is received to this Act, and it shall be sufficient defence for an employer to any proceedings concerning non-compliance with the PAYE regulations that they have taken all reasonable steps to notify any employee or former employee of their obligation to pay any liability created by this section.'.

Mark Hoban: I welcome you to our proceedings,Sir John. I made my debut as a shadow Treasury spokesman during debates on the National Insurance Contributions Bill late last year. In some respects, I was fortunate to have participated only at the tail end of those debates, but they were all about employment-related securities. As a result, when I looked at the measures before us to prepare for this debate, I felt rather like Yogi Berra, the baseball player—it was dÃ(c)jÃ vu all over again.
According to Budget note 33, the clause is intended to deal with
“complex and contrived schemes to avoid paying the proper amount of income tax and National Insurance contributions, exploiting the tax rules relating to options over shares and securities.”
Under UK tax law, options are specifically excluded from the definition of securities and are therefore not taxed on grant, but on exercise or a similar event, when the option holder realises some benefit from the option. Clause 92 further tightens the rules on options, and subsection (3) amends the definition of securities in the Income Tax, (Earnings and Pensions) Act 2003 so that it excludes only securities options, which are defined as a right to acquire shares. The change proposed in subsection (2) ensures that all other types of options are deemed to be securities and, therefore, to be taxed on grant, rather than on exercise.
In its submission on the clause, KPMG suggested that the new definition captures some fairly mainstream schemes for incentivising employees. Those include, for example, put options, which allow the employee to force the employer to take back or buy shares from them, share appreciation rights, phantom share option schemes, and share options and awards granted to those who are not ordinarily resident in the UK. Having said that, KPMG understands that HMRC now considers phantom share option schemes not to be options and therefore not to be caught by the clause, but I would be grateful if the Minister could confirm that. None the less, the range of incentive packages that are caught by the clause demonstrates how broad it has become, and some external observers of these proceedings believe that it goes beyond the statement of 2 December 2004 that the measures before us should relate to complex attempts to avoid paying tax.
In effect, the change in definition creates a wide class of options that will be taxed on grant, even when it is not clear that any benefit will accrue to the employee. Currently, the employee is taxed only when they have obtained some benefit through exercise. However, there could be good commercial reasons for using some of the structures that might fall outside the definition of a securities option. For example, it might be the right answer commercially for an enlisted company to issue put options to its shareholders, given the lack of a market for the shares. Although the Government might suggest that such issues could be tackled more satisfactorily using non-statutory concessions where there was uncertainty and ambiguity, some think that it might be better to have targeted, well-directed legislation to give those responsible for drawing up such schemes greater certainty.
Amendments Nos. 135 to 137 would change the focus of the clause. Amendment No. 135 would delete subsection (2), which inserts the words “options and”. In their place, amendment No. 136 would insert a main purpose test so that those schemes could be taxed differently when the main purpose is to avoid income tax or national insurance. That might be a more satisfactory way of targeting schemes and tackling the anti-avoidance practices that have grown up in that area.

Rob Marris: The hon. Gentleman brings us on to the thorny question of who defines “main purpose” and what it really means, particularly when we talk about incentives and so on, to which he referred. Would his amendment not be unworkable?

Mark Hoban: That is a very interesting question, and I am surprised that the hon. Gentleman raises that because throughout the Bill there are references to “main purpose”. For instance, when one of the principal purposes of a particular scheme is to avoid tax it should be under threat and consequently taxed. The Revenue is familiar with that, and I am sure that if we dig back through the annals of this Bill or others, we will find times when Opposition Members were critical of the use of a main purpose test. [Interruption.] Only two weeks ago.
That test is used, and it is an alternative approach to tackling the problems that we have discussed. Some of us are concerned that broadening the definition of an option scheme could create greater uncertainty than going down the route of “main purpose”. That is why the amendment has been proposed; it is a probing amendment, as are a number of our amendments, so that we can understand the schemes that the Government are trying to tackle.
Amendment No. 137 is a relatively small one seeking to insert “income” in front of “tax” at the end ofline 39. There is a concern that “tax” might be interpreted rather broadly. For instance, is it the Government’s intention to capture corporation tax as well?
Dawn Primarolo Yes.

Mark Hoban: The Paymaster General nods and gives verbal assent that the Government’s objective is to test that as well.
We come to another familiar debate: on retrospection and the tackling of schemes already in place, and on the date when the rules will come into effect. I have tabled amendments Nos. 138 and 139 which address the collection of liabilities from employees, particularly when a scheme has been in place historically and falls within the scope of the anti-avoidance provisions. They address also the question of who should be responsible for paying that tax, unpaid as PAYE, and national insurance—whether that burden should fall upon the employer or the employee.
I shall return to retrospection and the start date for the measures because concerns have been expressed about the breadth, variety and number of schemes that can be caught by the provisions, now or in the future, which would create added uncertainty in the minds of advisors about which schemes are available to use and which should be ruled out of order. Where legislation is more targeted and focused, it is easier for advisors to understand the use of retrospective legislation. Where legislation is more broadly drafted, advisors are much more conscious about the risk of retrospection and the danger that schemes that looked and were understood to be legal, and whose main purpose was not to avoid tax, are picked up. I tabled this brief series of amendments to probe the Government’s thinking on clause 2, and to push them on issues of the breadth and variety of schemes to which it will apply. What effect will it have on companies’ tax planning and how they seek to incentivise their employees?

Celia Barlow: In reference to the hon. Gentleman’s representations, I want to speak in support of clause 92 and its scope. The proposition has attracted some criticism from City institutions. I argue that such representations miss the point. The issue is fairness and justice.
For many years, we have been confronted with ever more sophisticated attempts by financial high flyers to avoid income tax or national insurance contributions, and sometimes both. I am sure that Members from all parties will agree that that is unacceptable and that we need to ensure that everyone earning money in the UK pays their fair share.
It is therefore necessary for the Government to clamp down on tax avoidance schemes, which not only lose Revenue money but also hurt the ordinary citizen’s common sense. In her written statement on 2 December 2004, my right hon. Friend the Paymaster General announced that complex and contrived attempts to avoid paying tax would be tackled in this Finance Bill if abuse of the system continued.
Briefings from financial institutions complain about the provisions’ alleged retrospection. The submission from KPMG mentioned by the hon. Gentleman argues that retrospective legislation is unwarranted in any case except in extremis. It states that the clause should come into effect with the announcement on Budget day. However, I believe that my right hon. Friend’s written statement was sufficient warning to the tax avoidance industry that, sadly, has developed.

Jeremy Wright: Does the hon. Lady think that it would have been helpful if, during the course of her statement, the Paymaster General had given the financial services industry some indication of what sorts of avoidance the Government had in mind?

Celia Barlow: My hon. Friend made some reference to those areas, and indeed has done so today. It is only right and proper to send a clear signal that we will not accept tax avoidance by those who have more than enough money to pay their fair share. It is a question of fairness, common sense and justice for all.

Philip Dunne: On the subject of fairness, does the hon. Lady agree that the wording of subsection 5 in particular appears to be open-ended? She used the words “alleged retrospection”. It is clear from my reading that the drafting of subsection 5 applying the measures to
“an option acquired before that date”—
namely, 2 December 2004—
“where something is done on or after that date”
is very wide-ranging. My question relating to fairness is whether she or the Paymaster General interprets that as potentially applying to years that have already been closed off by the Inland Revenue. Will those limits continue to apply?

Celia Barlow: The indication was clear. I shall read out my notes on that issue. On 2 December 2004, the Paymaster General made a statement setting out how the Government would deal with future tax avoidance schemes, warning that any counter-measures would be backdated to 2 December 2004 if necessary. Despite that warning and the Finance Act 2005, schemes continued to be promoted that sought to avoid income tax and NICs on employment reward using securities. Indeed, some employers have continued to engage in those schemes. I support the Government’s uncompromising stance and urge all Members to support the clause in its unamended form.

Dawn Primarolo: Let there be no mistake about it; the clause has a retrospective effect, potentially back to 2 December 2004, the date of the statement. It is not for accounts that are closed off, but a clear line was drawn for money that is still trying to cascade through the many and varied schemes. Indeed, Opposition Members have been very supportive of the need for such action.
We are talking about payments, bonuses and forms of employment remuneration that are disguised, and successive Governments have tried to deal with them. It started in 1991 with unit trusts; in 1993 it was gold bullion and other tradeable commodities, and in 1994 it was diamonds and fine wines. In 1995, there was anti-avoidance legislation on tradeable assets and vouchers, and in 1996 grants of share options in third party companies had to be dealt with, as did company share awards and options. In 1997 there was more on vouchers; and in 1998 it was conditional shares. Again in 1998, we dealt with readily convertible assets and with convertible shares; and in 1999 we dealt with the exercise of options.
The relentless march against those who seek to take employment remuneration without it being properly taxed continues. The evidence is that by 2003 £1.4 billion was going through those known schemes. Interestingly, the spokespersons for Her Majesty’s Opposition have supported such action. For instance, when discussing last year’s Finance Bill in Committee—it is a mirror image—the hon. Member for Cities of London and Westminster (Mr. Field) said:
“No one on the Opposition Benches will defend the payment in wine, gold or in other ways that was clearly an abuse of the system.”—[Official Report, Standing Committee B, 21 June 2005; c. 44.]
The hon. Member for Runnymede and Weybridge(Mr. Hammond) said
“No Conservative Member would defend highly contrived arrangements.”—[Official Report, Standing Committee B, 21 June 2005; c. 47.]
I could go on, but I utterly agree with them. In 2003, as we were wading through complex anti-avoidance legislation, the hon. Member for Yeovil (Mr. Laws), then spokesperson for the Liberal Democrats, said:
“The question is not only how much money has been lost— how much tax avoidance there has been”—
that is bad enough—
“but why we continue to have legislation year after year to deal with such avoidance schemes...surely we must consider whether we can introduce legislation specifically to address avoidance of income tax and national insurance contributions on remuneration in a way that will deal with the matter once and for all”.—[Official Report, Standing Committee A, 24 June 2004; c. 757.]
When I made the statement in December 2004, a clear line was being drawn.
I understand the points that the hon. Gentleman makes, but I must tell him in the gentlest possible way that the amendments will restrict the will of Parliament and not delivering the taxation that Parliament clearly wants for such remuneration. The amendments open up the possibility for remuneration in one form or another not to be taxed. I am sure that he does not intend that, but I want to explain why that would happen.

Julia Goldsworthy: In order to catch schemes that try to avoid what clause 92 attempts to overcome, does the right hon. Lady think it would be appropriate to have a pre-clearance scheme, so that HMRC could establish whether such schemes fell foul of the rules before they were introduced?

Dawn Primarolo: I have said it before: why should we give tax avoiders a pre-clearance scheme on how to get round the tax system? The law is clear, as is the statement, so there would be absolutely no point.
To deal with the two points that the hon. Member for Fareham raised, there is an issue with regard to phantom option plans and what are called the put options. The matter has been brought to the attention of my officials by some in the accountancy and legal professions, and HMRC officials have already made it clear on the website that, following the new legal advice, typical phantom option plans are not within the definition of securities options. Put options are rare but are sometimes used in takeover situations. Officials have examined the typical commercial situation and have confirmed that the put options used therein do not deliver employment reward. The Department therefore anticipates no adverse impact from their retention as securities.
Those inquiries have not identified any adverse impact on genuine commercial share option plans. However, if companies had concerns regarding the use of options in commercial circumstances not involving avoidance, they could seek a ruling from HMRC officials under the usual code of practice 10 procedure, as we have discussed before. In those circumstances where, as the hon. Gentleman mentioned, there is legitimate use that might be inadvertently caught, the position is quite clear. The operation of the code of practice 10 procedure means that once all the facts are put on the table and made clear to HMRC and an opinion has been given on that, companies are bound by that opinion.
The hon. Gentleman has sought to deal with those concerns, but unfortunately amendments Nos. 135 to 137 place a severe limit on the clause’s effectiveness in dealing with tax and national insurance avoidance. They would lead only to further revenue loss and provide opportunities for further exploitation of the legislation. To make it quite clear, the statement to Parliament in December 2004 drew the line and said, “That is the end. Whatever happens, you cannot use the schemes,” hence the backdating.
Amendments Nos. 135 and 136 have the admirable intention of simplifying the clause. However, the clause makes it clear that all options, other than those that are a right to acquire securities and were not acquired with the main purpose of avoiding tax or national insurance contributions, are within the normal charging provisions for securities and hence subject to existing anti-avoidance measures. Amendments Nos. 135 and 136, far from simplifying the clause, would therefore remove the clarity and lead to uncertainty, since the rules would be silent on the position of an option that was neither a securities option nor acquired with the main purpose of avoiding tax or national insurance contributions, such as an option that was a right to sell securities.
Amendment No. 137 seeks to narrow the effect of the clause by restricting its application to income tax and national insurance only. That would be an unacceptable weakening of the proposals.
My statement of 2 December made it clear that
“This Government are determined to ensure that all employers and employees pay the proper amount of tax and NICs on the rewards of employment, however those rewards are delivered.”—[Official Report, 2 December 2004; Vol. 428, c. 44WS.]
The phrase “however those rewards are delivered” in that sentence is crucial to the schemes that are devised. Avoidance schemes are being marketed to engineer a corporation tax deduction on employment reward, without a commensurate matching income tax charge on the employee. The schemes defer taxation indefinitely or until a considerable time after the employee has received the employment reward. I cannot see that using a wholly uncommercial option is anything other than avoidance, depriving the Exchequer of the proper amount of tax and national insurance and employment reward. I gave fair warning on 2 December 2004 that we would no longer accept that.
Amendments Nos. 138 and 139 attempt to prevent retrospective PAYE and seek to transfer from employers to employees the obligation to pay HMRC the tax arising, by virtue of clause 92, on earnings received prior to the date of Royal Assent for the Bill, thereby removing any obligation on the employer to account for the tax under PAYE. Since it is the employer who decides to pay earnings in such contrived ways, it is only right that, in accordance with the existing underlying principle of PAYE and national insurance, the employer should be held to account to pay the tax and national insurance. Amendments Nos. 138 and 139 would undermine the principle of PAYE and negate the timely payment of tax to the Exchequer by those who have chosen to pay earnings in a manner expressly intended to avoid a liability.
Amendment No. 140 would limit the backdating of the clause to the date of the Budget—22 March 2006—when the provisions were announced and published. That would undermine not only the clear warning that I gave on 2 December 2004, but future Government action to tackle avoidance. It would also give entirely the wrong signal to those who abuse security options to avoid tax and national insurance by allowing them to keep some of the tax and national insurance that they have avoided.
Let me dispel the notion that uncertainty prevails among practitioners—some of whom, I am sorry to say, perhaps supplied the amendments that we are discussing—by quoting from a post-Budget publication, issued by a firm of active advisers, appropriately called the “Tax Planning Newsletter”. It states:
“The main problem area for our clients would have been for those...who used one of the schemes which enabled bonuses to be taken from companies tax free. We had been warned by Dawn Primarolo that there was a danger of retrospective legislation in this area and we passed that warning on to clients. For some, however, it was a risk worth taking but it now appears that she meant what she said.”
Absolutely; I meant what I said. If clause 92 were only made effective from the date of the Budget, it would return us to the cat and mouse games of the past, where there was always a window of opportunity to manufacture and use an avoidance scheme before remedial legislation could be enacted.
We are determined that we will not return to these types of games around employment reward and that they should end. Avoiders will no longer have such an unfair advantage over those who have paid their fair share of tax and national insurance. The effect of the clause is clear: it applies only if security options are acquired or something is done to existing security options on or after 2 December 2004 that is part of an avoidance arrangement. The avoiders know exactly what they are doing, as Opposition Members have acknowledged at each point when we have discussed the various schemes over the years. Those who do not attempt to avoid paying the proper amount by participating in complex and contrived avoidance arrangements will have the certainty that these provisions do not apply to them.
Parliament is clear. It expects employment remuneration to be properly taxed. That is exactly the intention of the clause and it is regrettable that some people sought to test whether I meant what I said on behalf of the Government about a retrospective effect. I meant it and I hope that they take the lesson now and that a line has finally been drawn.

Mark Hoban: I am sure that readers of the “Tax Planning Newsletter” will take note of the Paymaster General’s comments. If they were uncertain, they must be certain now.
I want to make it clear that we support measures to tackle tax avoidance. The list of abuses that the Paymaster General read out included measures that we closed down when we were in Government, so we are cognisant of the risk of tax avoidance and the way in which people seek to hide remuneration through schemes that are dressed up as share option schemes and so on. People are always inventive and I am sure that they are even now looking at the Bill and wondering what measures the Government are introducing that they can use to their own advantage. As the Bill has progressed, various changes have been made to schemes introduced by the Government that have been used for tax avoidance.
I welcome the Paymaster General’s clarification of phantom share option schemes—it is good to have that clarification in the Committee as well as on the Customs and Excise website—and put options.
I will leave to another day how the code-of-practice-10 process for clearance of schemes differs from the pre-clearance scheme mentioned by the hon. Member for Falmouth and Camborne, but the fact that the process exists for those with legitimate schemes is welcome. Those who use that process should recognise the important words used by the Paymaster General when she referred to full disclosure of the facts of those schemes. That is important.
On retrospection and clarity, I do not wish to relive in gory detail the Report stage and Third Reading of the National Insurance Contributions Bill—[Hon. Members: “Go on!”]—despite the temptation from my hon. Friends who are egging me on. Before this debate, I checked to see whether I said anything that I might regret and I am pleased to say that I said nothing then that I regret now. In response to the hon. Member for Hove (Ms Barlow), the import of the Paymaster General’s statement on 2 December 2004 was not clear to a number of people and we discussed it on Report and Third Reading. Some advisers did not read her comments as broadly as they turned out to be. Today’s debate has emphasised the breadth of those comments, but for a number of people the statement on 2 December 2004, in conjunction with the Government’s later actions, came as a surprise and any doubts they may have had have been dispelled. I am sure that that will be reinforced in subsequent debates.
I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 92 ordered to stand part of the Bill.

Clause 93

Corporation tax relief for shares acquired under EMI option

Question proposed, That the clause stand part ofthe Bill.

John Healey: The clause takes us to the enterprise management incentive scheme. It is designed to correct a small defect in the rules on corporation tax relief that we introduced under schedule 23 of the Finance Act 2003. The change under clause 93 will allow the intended corporation tax relief when restricted and convertible shares acquired under the enterprise management incentive options are granted at a discount to market value.
At present, the amount of corporation tax relief allowed is equal only to the amount of the discount. That is not intended, so the clause gives the correct corporation tax deduction for both the amount of the discount and the amount that would have been taxed on the employee but for the income tax relief given under enterprise management incentive legislation. The change will ensure that a company offering enterprise management incentive options will not be disadvantaged by receiving a smaller corporation tax deduction compared with one that offers fully taxed share options.
There was no intention to disadvantage EMI options that were granted in the discount in that way when the original schedule was introduced in 2003. The measure under clause 93 has therefore been backdated to 1 September 2003, which was the date on which the relevant income tax legislation relating to restricted and convertible shares came into force. I commend the clause to the Committee.

Question accordingly agreed to.

Clause 93 ordered to stand part of the Bill.

Clause 94 ordered to stand part of the Bill.

Clause 95

Profit share agency

Question proposed, That the clause stand part ofthe Bill.

Edward Balls: We now come to a short series of four clauses. They take forward the work that has been proceeding since 2003 and, in particular, since last year’s Finance Bill to address Islamic finance and the importance of providing financing vehicles that are available to people from the Muslim community and consistent with their religious beliefs in order for them to access financial products.
The objectives of the package of measures begins under clause 95. The provisions provide a level playing field and fair tax treatment for alternative finance products that, in turn, remove obstacles to innovation in financial markets. They build on the measures that were introduced last year to provide a level playing field for basic financial products and extend them to cover further products, following ongoing and substantial consultations with industry and interested parties. The measures will be of benefit to everyone who wants to access to financial products that do not involve interest, but they will be of benefit in particular to those members of the Muslim community who wish to avoid interest for religious reasons. The existing tax laws can be difficult to apply to such products and can give awkward results. The clause is designed to provide consumers with certainty in their tax position.
The clauses are developed in partnership with business and its professional advisers, and bring the tax treatment into line with equivalent products that involve interest. Clauses 95 and 96 set out the tax treatment of two particular financial products and align the tax treatment to that of their conventional equivalents. Clause 97 ensures that beneficial loans legislation applies to alternative finance arrangements as well as to conventional products. Clause 98 contains a regulatory power to allow further similar products to be incorporated into the tax system by Treasury order and provides the Government with the flexibility to respond quickly to developments.
Clause 95 enables a new long-term finance product in the form of an agency relationship that gives a similar income account fund to a deposit of money at interest. The Finance Act 2005 provided a return on particular arrangements, calling the legislation a profit share return, to be taxed in the same way as interest. The clause extends that definition to include the return from a profit share agency arrangement under which certain conditions are met. It means, for example, that the rules on deduction of tax from bank or building society interest apply to the return from profit share agency arrangements. It ensures that both the investor and the financial institutions are taxed fairly on the financial return that each makes on the arrangement. It also contains some further changes to the legislation to ensure consistent treatment between the agency-based product and conventional interest-based products. I commend the clause to the Committee.

Theresa Villiers: I must start by apologising to the Chairman and to the Economic Secretary for missing the first few seconds of his presentation. I will follow his example in addressing clauses 95 to 98 together. I am slightly worried that I find myself in agreement with him on the proposals. They are welcome because, as we have heard, they provide a legal and tax framework to accommodate two further sharia-compliant finance arrangements.
The Koran provides:
“Oh you who believe, you shall not take usury compounded over and over. Observe God that you may succeed”.
At another point, it states:
“God does not bless usury, and he causes charitable deeds to prosper”.
Some interpret the prohibitions in the Koran to cover only usury. However, it seems more generally accepted that the ban extends to the paying of interest or riba in any transaction. Considerable effort has therefore been made over recent years to develop financial products that suit the needs of the Muslim community, but which also enable it to comply with sharia law and avoid interest, as we have heard from the Economic Secretary. Last year’s introduction of a financial framework for two sharia financial products, morabaha and modaraba, were widely welcomed.
Clause 95 provides similar legal certainty for the wakala contract, which involves profit share agencies. Clause 96 performs the same function in relation to diminishing musharaka products, which use diminishing shared ownership arrangements. There are a number of reasons why it is important to ensure that the United Kingdom’s tax and regulatory structures embrace sharia-compliant products such as those. It is important to ensure that the UK’s Muslim community is encouraged to save and deal prudently with managing its finances. I recently had the pleasure of visiting a mosque in north Finchley. It falls just outside my constituency, but its catchment area covers my constituents. The much respected imam at the north Finchley mosque, Mr. Mufti Barkatullah, is an expert on Islamic finance. He advises several banks, including Lloyds TSB, on sharia-compliant products. He believes that providing such products is vital to improve prosperity levels in the Muslim community.
At a recent meeting in north London, Mufti Barkatullah was quoted in the papers as saying:
“Much of the deprivation among Muslims is because they don’t find the financial world friendly to their ethics. They find it hard to believe that financial institutions are becoming friendly. I am here to reassure them.”
I am sure that the Committee will be aware of the tensions that we have seen in some cities with large Muslim communities where deprivation levels are high. No doubt action on many fronts will be needed to reverse that, but a thriving Islamic finance sector could be helpful in that regard.
Ensuring that we are an attractive location for Islamic finance could give us an important competitive edge. The Islamic financial sector has been experiencing high levels of growth. The law firm Clifford Chance recently estimated that the sector is worth about $2 billion with very fast growth in areas such as sukuks, which are Islamic bonds. Moody’s, the credit ratings agency, recently announced that it was setting up an office in Dubai to provide credit ratings for those bonds and other Islamic financial instruments. It estimates that the world’s 200 Islamic mutual funds are handling assets worth £161 billion and, of course, serving the vast Muslim population of India’s increasingly successful economy is also likely to open up huge business opportunities.
Other areas of growing business include Islamic leasing or ijara, Islamic hire purchase or ijara-wa-iqtina, Islamic asset-backed securities, and Islamic risk-mitigating instruments. Insurance, once frowned on in the Islamic world, is also growing with the spread of takaful products. HSBC Singapore manages about 280 million such funds. HSBC has also developed a number of sharia-compliant mortgages and pension plans in this country.
Using a 1,400-year-old law to govern modern contracts is not without its challenges. Such is the dramatic success of the Islamic finance sector that the Financial Times on Friday reported an increasing shortage of scholars with the expertise to advise on such matters. The procedures required before a product can be authorised as sharia-compliant can make the Financial Services Authority process look positively tame and simplistic. In many cases, authorisation is needed from a board of 15 scholars that meets only twice a year in Mecca and Medina.
Another reason for supporting the Government’s attempts, this year and last year, to adapt our legal framework to encourage Islamic financial products is that in a world in which there is increasing anxiety about the relationship between the Islamic world and western Governments, it is good to see an area in which financial institutions at the forefront of our capitalist economy are working harmoniously to meet the needs of the devout and the Muslim community.
Finally, I sound a note of caution. While these clauses facilitate sharia-compliant finances, in schedule 20 the Government are undermining the freedom to create sharia-compliant wills. I shall explore the issue when we debate that schedule, but it is another reason for the Government to look afresh at schedule 20 and to review the proposals in it.

Sadiq Khan: I am afraid that my Arabic is no better than that of the hon. Member for Chipping Barnet and the Economic Secretary.
I welcome the provisions in this Bill and in last year’s for sharia-compliant wakala and musharaka products. I agree with the compliments that the hon. Member for Chipping Barnet paid to Mufti Barkatullah. It is pleasing to see not just a fantastic British Chancellor leading the way and making sharia-compliant products feasible, but HSBC doing so too. The good thing about clauses 95 to 98 is that they provide opportunities for British citizens of Islamic faith and British companies that wish to pursue an Islamic ethos, as well as letting overseas companies know that the UK is Muslim-friendly. We have here examples of alternative financial arrangements that are beneficial for loans to employees, for those who wish to have diminishing shared ownership and for profit-sharing agencies.
Let me formally welcome the Economic Secretary to his new position. I know that he has been welcomed by every member of this Committee over the past seven years—sorry, six weeks—but my question is, can he assure us that the fantastic work that we have seen over the past two years will continue? In particular, will Her Majesty’s Treasury and HMRC continue to consult representatives of banks, businesses and the Muslim community on the tax treatment of arrangements that achieve the same result as conventional financial instruments without involving payment or receipt of interest? The hon. Member for Chipping Barnet has given examples of some of the things that are prohibited by sharia law. The important assurance that my hon. Friend the Economic Secretary can give us will be that the excellent work undertaken hitherto will continue in the weeks, months and, dare I say, decades of this Labour Government.

Question accordingly agreed to.

Clause 95 ordered to stand part of the Bill.

Clause 96

Diminishing shared ownership

Question proposed, That the clause stand part ofthe Bill.

Edward Balls: The clause has already been discussed in so far as it refers to musharaka arrangements, which are basically partnership-based products that are economically similar to secured loans. I can confirm that in this instance and the previous one we consulted widely with the Muslim community and with the financial industry and its advisers. In each case, the product was highlighted as being one for which there is a demand that cannot be met because of the current uncertainty about tax treatment. These clauses provide the certainty that will allow such trade to go ahead.
I can also assure my hon. Friend the Member for Tooting (Mr. Khan) that over the coming months we will continue to consult the community and its financial advisers. As London is increasingly accepted around the world as a centre of expertise for such products, it is important for the strength of the City of London that we continue to support the parts of the City that provide special products. I definitely will be having meetings and will be seeking his advice on the best people to consult to ensure that we are at the forefront of thinking in this area. I can also tell him and others that the Chancellor of the Exchequer will be speaking at a conference in the next few weeks at which these issues will be addressed directly in discussion with members of the community and experts. I can definitely give him the assurance he seeks that in the months, years and decades ahead we will continue to consult as we have been doing.

Question put and agreed to.

Clause 96 ordered to stand part of the Bill.

Clauses 97 and 98 ordered to stand part of the Bill.

Clause 99

Amendment of section 29 of theEnergyAct 2004

Question proposed, That the clause stand part ofthe Bill.

Paul Goodman: It is a pleasure to welcome you to the Chair, Sir John. Although I am half hypnotised by the beautiful blue sky outside that the Paymaster General referred to earlier and which, alas, she cannot see, I do have a few questions on clause 99. I hope that she and Ministers will allow me to sketch out briefly what the clause does before I ask them.
In essence, the Energy Act 2004 reorganised the nuclear industry. It made accounting entries of certain publicly owned companies—I stress the word “publicly”—in the British Nuclear Fuels group not liable for corporation tax purposes, dependent on certain events of reorganisation taking place. Those events duly took place, but the European Commission launched an investigation into state aid in respect of nuclear decommissioning. Transitional financial arrangements were then set up, which meant that the intention of section 29 of the 2004 Act to exempt transactions from corporation tax no longer applied. The clause seeks to reapply them. So far, so dry.
There is, however, a rather more interesting development. It is worth noting that since the Budget it has been announced that one of the BNFL companies—British Nuclear Group, which is its specialist site management and nuclear clean-up business—is to be transferred from the public to the private sector. During the Budget debate, the then Trade and Industry Secretary, who is now the Secretary of State for Education and Skills, stated in words that did not apply to the deputy leadership of the Labour party but to this subject:
“We must...ensure that elements in public ownership that do not need to be in public ownership to meet our objectives on decommissioning are put into the private sector.”—[Official Report, 28 March 2006; Vol. 444, c. 699.]
That sounds reasonable in principle. Obviously, Members on this side of the House look sympathetically—although not favourably in all cases—on the case for transferring services from the public to the private sector. However, this is where the questions arise.
If I am not mistaken—Ministers will correct me if I am—it seems that an exemption from corporation tax that applied to a public body is now to be applied to a private body, and in circumstances in which there is a sale. Can Ministers explain what connection there is, if any, between the exemption and the sale? It was put to me, perhaps wrongly, that the exemption could simply have been intended to make the sale more attractive. I would like to know whether that is the case and, if so, what the cost of the exemption will be. Finally, are there precedents for this kind of exemption? If so, what are they? The Paymaster General may be able to refer me to a large number of exemptions in the years of Conservative Government, but I am curious about that.

Rob Marris: I find the clause difficult to understand, perhaps because it comes under the Energy Act and I am not an energy expert. However, I understand the explanation given in his introductory remarks by the hon. Member for Wycombe (Mr. Goodman). But further to that understanding it appears to me—I may have got it wrong—that, under the Energy Act 2004, a certain tax regime was set up. The European Commission said, “Well we think it might be unauthorised state aid,” so clause 99 of this Bill was drafted to rejig it slightly. That prompts the question whether we have still got unauthorised state aid, albeit in a different form, overlaid, as the hon. Gentleman rightly pointed out, with the possible privatisation of British Nuclear Group, a site management and clean-up company, which seems to be shadowed in clause 99(4)(a)(b)—for the anoraks among us, it is on page 93, line 11—which states:
“a company that immediately before 1st April 2005 was a wholly-owned subsidiary of BNFL”.
That would count under the Energy Act 2004 as the definition of a BNFL company, even though it may have been privatised since 1 April 2005.
Stepping back from that to the politics of the matter which, heaven forfend, we have in the Finance Bill, it appears at first glance that not only section 29 of the Energy Act 2004 but the proposed amendment to it looks like another subsidy to the failed nuclear industry, which uses old-fashioned technology, has never paid its way anywhere in the world and has left us and succeeding generations for the next 186,000 years, or whatever is the half-life of a uranium atom, with a huge clean-up problem.
Clause 99 appears to further a subsidy for an industry that is a failure financially and works around the world only with continuing subsidies from the states in which it operates, as evidenced by the fact that, as far as I am aware, there are no applications around the world for permissions to build new nuclear power stations unless they are state sponsored or state subsidised, whether they are in Finland or in China. Anyone could apply to build a nuclear power station in the United Kingdom now; the head of E.ON UK which is, I think, wholly owned by the German E.ON company, could say, “Well, I think we need new nuclear power stations,” but not actually put in an application to build any.
We cannot have the whole nuclear debate now, as you would not allow it, Sir John, but I would like reassurance that clause 99 is not a further subsidy to the nuclear industry.

Helen Goodman: I echo the questions already asked by hon. Members on these two clauses; I simply want to ask Ministers to explain how the proposals will operate and what the cost will be.

Dawn Primarolo: May I first respond directly to my hon. Friend the Member for Wolverhampton, South-West? The answer is no; it is not a further subsidy, and I shall explain what happens. The clause amends section 29 of the Energy Act 2004, as the hon. Member for Wycombe said.
Section 29 was intended to prevent a BNFL site licensee company from incurring corporation tax charges as a consequence of accounting entries made to reflect the assumption of financial responsibility for decommissioning and clearing up certain civil nuclear sites by the Nuclear Decommissioning Authority. Section 29 proceeds on the basis that the recognition of the assumption of financial responsibility by the NDA would relate to specific events. That is not the case.
The amendments are required to ensure that the appropriate accounting entries are included and to ensure that the companies will not incur tax charges solely because of the accounting for the recognition of the assumption of financial responsibility. It is to do with the interaction between those companies, as the hon. Member for Wycombe mentioned.
To take the matter further, let us deal with the question of precedent. In 2005, the Government took over responsibility for British Energy plc’s liability for decommissioning and certain other liabilities. The resultant credit in the accounts was exempt from tax by way of similar provisions to these in section 4 of the Electricity (Miscellaneous Provisions) Act 2003. Section 29 of the Energy Act 2004 was intended to prevent a large amount of money moving in circles, and to take account of the accounting practices. The reorganisation could not have gone ahead if tax charges had arisen, and this clause preserves the intended tax treatment. It is a case not of giving up forecast revenues, but of preventing an inconceivable and unexpected charge that would arise solely because of the timing of events and the accounting for reorganisation. It has been done before.
The hon. Gentleman asked me for examples of precedents in the transfer between public authorities. Although I recognise that the BNFL group includes the private sector, tax and liabilities follow the normal tax provisions. The provision goes no further than that; it is simply a tidying-up measure. It was originally undertaken in an Energy Act, and the reason why it is being undertaken in the Finance Bill is because there is no suitable vehicle for dealing with it apart from the Finance Bill. The provision could have been included in another Energy Bill had there been one.
With regard to the hon. Gentleman’s point about any proposal to sell off British Nuclear Fuels or part of it, the Energy Act 2004—not this Bill—provided that the Nuclear Decommissioning Authority would be given responsibility for decommissioning and clearing up the designated nuclear sites and installations. Section 29 was a practical measure to prevent a large amount of Government money moving in circles from one Department to another. Under ordinary tax rules, the account in credit arising when the NDA takes over responsibilities would count as a taxable income resulting in a liability that BNFL would not be able to fund from its own resources.
Section 44 of the 2004 Act stripped BNFL of its tax losses. It represents the other side of the coin in this removal, ensuring that they are both in accord. This clause preserves the intended effect of section 29 of the 2004 Act, and it is included in this legislation for no other reason.

Rob Marris: This is complicated, revolving-door finance, but taking my right hon. Friend back a couple of sentences, I understood her to say—or words to the effect—that without section 29 and because of nuclear liabilities moving over to the Nuclear Decommissioning Authority, BNFL would not have been able to meet its tax liability. I think that that was what she said, and she will correct me if I am wrong. If that is the case, is not it an indication that BNFL does not work financially?

Dawn Primarolo: As my hon. Friend said, this is not the place to discuss an Act that went through the House in 2004. The provision before us simply ensures that the 2004 legislation follows the accounting practices and reflects the reality. It would not be appropriate for me to go over discussions that took place when that legislation went through the House.
The hon. Member for Wycombe asked me one further question, and I cannot remember whether I have covered it. He asked whether there are examples of a similar arrangement being made to prevent the circular movement of Government finances. There are such examples. I do not have them to hand, but I am happy to let him know what they are. There is nothing unusual about this measure; there are precedents. There is not a huge number, but there are examples and if the hon. Gentleman would like to know about them, I will do my best to write to him.

Question put and agreed to.

Clause 99 ordered to stand part of the Bill.

Clause 100

Amendment of section 30 of theEnergy Act 2004

Question proposed, That the clause stand part of the Bill.

Mark Francois: On a point of order, Sir John. I apologise for troubling the Committee with a point of order, but if I remember rightly—admittedly, I am going back to April—when we had the debates on the Budget resolutions, the Liberal Democrats specifically broke out the issue of nuclear decommissioning because they wanted to vote on it. Procedurally, it is rather an odd thing to do to call something out for debate and then not even to touch on it in Standing Committee.

John Butterfill: Order. The hon. Gentleman has made his point, but it is not a point of order for me.

Helen Goodman: We also asked the Minister whether she knew what the costs of the measure were, and she was not able to give us an answer in her speech. I can understand if that information is not available this afternoon.

Dawn Primarolo: I answered my hon. Friend’s point. When she asked about the cost, I said that the measure was to prevent a large amount of Government money from moving in circles. There is not a cost; the measure is to prevent the shifting of that money. I am happy to amplify the point by writing to my hon. Friend and to other members of the Committee, but we are talking about bringing things in line with accountancy facts, according to the transfers.

Question put and agreed to.

Clause 100 ordered to stand part of the Bill.

Clause 101

Securitisation companies

Question proposed, That the clause stand part ofthe Bill.

Theresa Villiers: The Opposition welcome the clause, which extends the temporary tax and accounting regime for securitisation companies to the end of December 2007. It confirms that, during that period, securitisation companies can continue to calculate profits under UK GAAP—generally accepted accounting principles—rather than switching to IFRS, or international financial reporting standards.
The clause is important because of the crucial role played by securitisation companies. As I am sure the Committee is aware, securitisation is a type of shock-treatment finance used to pool assets and income streams into a single tradeable security. The assets can be any financial assets, such as mortgages, corporate loans or rent receivables. The companies at issue here are special purpose vehicles that have beneficial ownership of the assets and receive the income that they generate. They use the value of the future income stream to issue securities—generally, debt instruments that are traded on the market.
Securitisation has revolutionised the operation of financial markets. It has enabled a range of diverse financial assets to become tradeable and has opened up a whole new investment area by enabling risk to be split much more easily between multiple lenders. It has enabled groups of lenders to be linked with borrowers in a way that was never possible before. The global market for securitisation is worth about $6.6 trillion, or at least it was in 2003—the figures have probably increased since then. It is well worth putting it on the record that maintaining the right tax and regulatory framework is crucial to securing a thriving bond market in London and a healthy financial centre in the City of London.
The issue that the clause is designed to tackle results from the move to international financial reporting standards, which causes a particular problem for securitisation companies. Because securities are issued by SPVs and are traded, it is crucial that they can attract a good credit rating for those securities, because without that the costs of borrowing spiral. One of the factors taken into account by the ratings agencies relates to the level and consistency of tax charges.
Under the UK generally accepted accounting practice, profits are broadly calculated as income receivable from the assets less interest payable on the traded security, and tax is payable based on those profits. In short, the SPV is taxed on the income it receives net of the interest charged. However, international financial reporting standards require that the traded security is accounted for on a marked-to-market basis. That means that it is revalued for each balance sheet date based on its market value, and the difference is booked to the accounts via an income statement or the reserves.
The differences are taxable and that gives rise to significant fluctuations between taxable profits from one year to the next. The effect is that instead of the smooth taxable result that one gets under UK GAAP, the tax charge becomes highly volatile. Despite the SPV having a stable income stream, large peaks and troughs in its tax bill could threaten its ability to pay, which would be of considerable concern to the ratings agency and could have a significant impact on the rating of the bonds issued by the SPV.
So, the switchover to IFRS could cause ratings previously given to securitisation companies to be downgraded, hence the welcome decision to allow such companies to continue to use the old UK GAAP rules. However, that solution was only ever intended to be temporary. It is not ideal because it means that securitisation companies effectively have to draw up two sets of accounts and there is, as yet, no indication of when a new permanent set of rules will be developed and published.
I urge the Minister covering this issue to give the Committee some indication of what stage the Government have reached in preparing those long-term rules. I urge them to prioritise making progress on this important matter, given the highly significant role that securitisation companies play both in our financial markets and in our economy. It is important to bear in mind that most securitisations are done on long-term debt issues, where long-term certainty in respect of the tax regime is obviously highly desirable. I also emphasise the importance of providing for effective consultation in finalising the rules.
Lastly, will the Paymaster General consider giving some kind of undertaking that the temporary provision will stay in place until the permanent new rules are introduced. I hope that she will be able to give us assurances on the issues that I have raised in relation to this matter.

John Butterfill: I am happy for the Paymaster General to reply to the questions on international accounting standards raised by the hon. Member for Chipping Barnet. However, I do not think that it would be appropriate for this then to develop into a debate on the various merits and demerits of the international accounting standards.

Dawn Primarolo: I shall briefly respond to the points raised. The hon. Member for Chipping Barnet is right that a temporary arrangement was made and it is desirable that we should move to a permanent arrangement as quickly as possible. The temporary arrangements are far better than moving now to the international accounting standards for the reasons that she has given.
The hon. Lady asked me to give an indication of the Government’s plans in trying to move towards the permanent regime. I hope that draft clauses will shortly be available for consultation with the industry on how to move to a permanent arrangement. Given all her points about the importance of liquidity, I would like, as I am sure the industry would—that is the advice I have received—the consultation to be concluded in good time to enable the permanent regime to become operational on 1 January 2007. Obviously, that means that we need to get the drafts out as quickly as possible, and that is what we intend to do.
As the hon. Lady rightly says, the clause is a temporary extension of a temporary arrangement. It is important in this crucial area of availability of finance that we seek to make permanent arrangements as quickly as possible. I hope that she finds that helpful.

Theresa Villiers: I do find that helpful, and I welcome that indication regarding timing.

Question put and agreed to.

Clause 101 ordered to stand part of the Bill.

Clause 102 ordered to stand part of the Bill.

Schedule 15

Accountancy change: spreading of adjustment

Theresa Villiers: I beg to move amendment No. 216, in page 77, line 13 [Vol II], leave out ‘22nd June' and insert ‘10th March'.

John Butterfill: With this it will be convenient to discuss amendment No. 217, in page 80, line 27 [Vol II], leave out ‘22nd June' and insert ‘10th March'.

Theresa Villiers: The amendments would backdate the relief to the date of the publication of document UITF 40 on 10 March 2005. To show the rationale behind the amendments, it is necessary to set out the background to the issues that we are discussing. Clause 102 and schedule 15 deal with the taxation of work in progress and the impact of FRS 5 and UITF 40, which was issued by the urgent issues task force of the Accounting Standards Board. Affected businesses include service providers such as solicitors, marketing and advertising firms, accountants, insurance brokers and consultants of various descriptions. That covers a number of Committee members, in one way or another. I believe that one or two of the provisions in schedule 15 also impact on barristers, so I suppose that I should admit that I was one, at one stage.
In broad terms, FRS 5 is the UK accounting standard that seeks to look through legal form and account for the substance of transactions. It is one of the most complex and hard to understand of all the UK accounting standards. Application note G of FRS 5, which was issued in November 2003, sought to deal with service businesses with large contracts. It set out new rules for the accounting treatment of the period when the contract was ongoing. In the past, the profit on the contract was recognised when it was completed and taxed, which tended to be when the payment was received.
Application note G required that the amount was brought into account as soon as there was a contractual right to payment as a result of performance under contract. Problems arose because it was interpreted differently by different accountants. Some required professionals whom it affected to bring amounts into account evenly over the performance of the contract, whereas others felt that it was sufficient to bring amounts into account when performance occurred.
The urgent issues task force looks into such areas of uncertainty in relation to application of accounting standards. It issued UITF 40 to deal with the question of whether profit should be recognised as the contract progressed under the new method, or on completion of the old method. The key factor is the point at which consideration is legally due. UITF 40 considered that it accrues as time goes by, hence the new method was adopted.
The overall effect of UITF 40 is that a large, one-off tax bill arises for solicitors and other service providers affected. That caused considerable anxiety, as did the prospect of having to pay tax on ongoing work for which the firm might not yet have been paid. To its credit, the Revenue has recognised that problem by introducing schedule 15 essentially to spread that one-off tax charge over three to six years. It does not reduce the tax charge, but merely spreads the time over which it is payable.
In principle, the change provides some welcome relief, but serious concern has been expressed by the professional associations regarding the implementation dates. As drafted, the relief set out in schedule 15 applies only to businesses that adopted UITF 40 from its official start date on 22 June 2005, but many businesses adopted the approach in UITF 40 before then. That may have been because their auditors advised them to do so, or simply because they wished to follow best practice. However, paragraphs 1 and 9 of schedule 15 deny the relief to any firm that adopted UITF 40 before its start date.
The Chartered Institute of Taxation and the Law Society have both pointed out that it seems unfair to penalise such firms because they acted swiftly in seeking to apply the highest accounting standards, and the amendment seeks to backdate the relief so that those firms can claim the spreading relief.
The Institute of Chartered Accountants has stated that 
“this sends out a powerful message to business that early adoption of accounting standards in accordance with the highest standards of corporate governance will be encouraged and will not result in such businesses being penalised.”
The amendments are modest, and as many firms started to amend their procedures for drawing up accounts even in advance of the publication of UITF 40 there might even be an argument for backdating the measure further, as the Law Society has suggested. The Law Society also observed that the proposal is not for a tax reduction; instead it would allow more time for firms to spread the cost of what the society has described as a one-off windfall tax for the Treasury.
As drafted, the Bill perversely rewards those who left it as late as possible to adopt best practice. Given the need to encourage high standards of corporate governance, I hope that the Government might be prepared to consider the amendments that I have proposed.

David Gauke: I declare that I am a non-practising solicitor. My attention was drawn recently to an article in Taxation magazine. I do not know whether that is a publication that should be treated with the same scorn as a tax planning magazine, but I am told that it should not. The article was by Mr. John Endacott, a partner at Winter Rule chartered accountants. [Interruption.] No, it was not by Mrs. Gauke, though Mrs. Gauke drew it to my attention; I should perhaps declare that my wife is a practising solicitor. The article, which was published in January 2006, stated that around 70 per cent. of the top 100 law firms had already decided to adopt the new standard by the end of 2004 and that it was likely that the remaining 30 per cent. would have done so by the time of publication of the article. Mr. Endacott was extremely critical of the Treasury in its approach to spreading. He stated that
“What we have here is firms being penalised for adopting good accounting practice...It is therefore a very limited relief being introduced in a mean-spirited and divisive way”
—given that most firms will already have changed their accounting systems. He added that
“firms embracing modern approaches have to suffer the tax consequences of doing so, whilst the laggards benefit from some relief.”
Schedule 15 attempts to address an unfortunate circumstance, but it fails, because for the vast majority of firms it will be unavailable. Most firms that are likely to seek to comply quickly will have been required to do so by their auditors and will already have changed their accounting systems, so there is nothing in the schedule to assist them. That is petty, and I should like to know why the Treasury has adopted that route rather than making the provision effective as of 10 March 2005 or November 2004 when the accounting standards were developed.

Dawn Primarolo: I should make it clear that the Government are not penalising those who followed the UITF 40 interpretations in accounting periods ending before 22 June 2005. They will pay the same tax as they would have paid had the Government not included the measure in the Bill, and on the same date. They will pay the same tax as they would have paid had the Government not included the measure in the Bill, and on the same date. They will face no additional charge that they could not have anticipated when they decided on their accounting policy for a period, at which point they would have examined the matter carefully and taken advice. The amendments ask us to do something that is incredibly complicated and could result in more tax liability in years that have already been dealt with. I shall explain why.

Rob Marris: I think we should vote for it. [Laughter.]

Dawn Primarolo: I thank my hon. Friend.
Even those who are not accountants will understand that it would be difficult to set a start date of 10 March. Income tax payers’ accounting dates are up until 5 April 2005, so we would have had to include the effect of the first year’s spreading in 2004-05 tax returns, which were due at the end of January this year. The provisions of the Bill were not available to help people at that point, and they would be able to take advantage of the new laws only by amending their returns. Spreading adjustment income from 2004-05 would also reduce taxable income from that tax year, but would consequently increase taxable income in 2005-06 and subsequent years. The amendment would therefore impose a tax charge for the first time in 2005-06, rather than in 2006-07 as would be the case with a start date of 22 June 2005.

David Gauke: Will the Paymaster General give way?

Dawn Primarolo: Hang on. Let me answer the points. If I have not dealt with them, the hon. Gentleman can reinforce them.
In setting dates, it is always difficult to establish who knew what when about the changes being made, but I took the view that it is fair to put the start date for spreading at the date on which the new accounting interpretations became compulsory rather than at some interim point that can be justified only because it was the start of a new tax year. That would still leave a group of early adopters feeling unfairly treated. I emphasise nobody will be penalised because they adopted early. They will not face any additional tax charge but will pay the same tax on the same date as they would otherwise have done. Even the hon. Member for South-West Hertfordshire (Mr. Gauke) can see that to go back into tax years that are already closed off would present untold problems, particularly in the case of complex partnership arrangements. It is a matter of judgment, and my judgment is that the right start date for spreading is the date on which the requirements were finally introduced. That is the decision that the Government have made.

David Gauke: I hear what the Paymaster General is saying, and I can see some of the practical difficulties involved. Is it not a fact, however, that most firms changed their accounting practices before it was compulsory to do so? If the policy objective of the schedule is to relieve the burden on firms that are changing their accounting systems and to spread out the windfall cost, did not the Treasury miss a trick a year or two ago? It should have brought in legislation equivalent to the schedule earlier, so that we would not be in a position in which there is practical difficulty and in which we cannot go back to before 22 June? Is that not the problem?

Dawn Primarolo: No, it is not. It is not for the Treasury to anticipate when accounting standards and directions will be made and to legislate accordingly. Those companies that looked at the statements that were being made and the possible changes that were coming forward took decisions about whether or not to be early adopters. That was sound advice for their business, and they moved in that way. As long as they are not disadvantaged, which they are not, I cannot see what the problem was.
In this example, the Opposition are seeking to put phenomenally complex legislation in place that could result in a tax charge on those who currently do not face one. If the Opposition want to put their amendment to the vote I shall ask my colleagues to oppose it. If they do vote it in, I do not think that they will be thanked by those companies that might find themselves with a tax charge.

David Gauke: I hear what the Paymaster General is saying about it not being the role of the Treasury to anticipate what firms will do when it comes to changing their accounting practices. However, as we have just heard, 70 of the 100 largest law firms had already changed their accounting practices by the end of 2004. It is not a question of anticipation, as during the course of 2005 the Treasury might have noticed, received representations and acted then. Instead, it is acting now with schedule 15. Presumably its purpose is to try to help firms and there is an objective that is meant to be achieved, but that objective will not be achieved because the vast majority of firms that will be affected will not benefit from the schedule as they had already done changed their accounting by the end of 2004. We are talking about a whole year when the Treasury did not act and should maybe have done so.

Theresa Villiers: I share the concerns of my hon. Friend the hon. Member for South-West Hertfordshire and think that it is unfortunate that the Paymaster General is not prepared to accept the amendment. I will withdraw it and will not press it to a vote, bearing in mind the practical difficulties with the amendment that the Paymaster General has outlined. I echo the points made by my hon. Friend; it was clear that the shift was underway and it was entirely desirable that it would be underway at an early stage. I appeal to the Paymaster General to try to ensure in future that early adoption of best practices in accounting is encouraged by the tax system and not, as in this case, discouraged. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 15 agreed to.
Further consideration adjourned.—[Mr. Heppell.]

Adjourned accordingly at seventeen minutes to Seven o’clock till Thursday 8 June at five past Nine o’clock.